SHANGHAI FUND MANAGERS ON JV'S AND COMPETITION

UNCLAS SECTION 01 OF 03 SHANGHAI 000657

SIPDIS

SENSITIVE
SIPDIS

STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN
FRANCISCO FRB FOR CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK
STATE PASS CEA FOR BLOCK
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/LOI/READE
USDOC FOR 4420
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN
TREASURY FOR EXEC - TSMITH, OASIA/ISA -DOHNER/BAKER/CUSHMAN
TREASURY FOR WRIGHT AND AMB HOLMER
TREASURY FOR SOBEL AND MOGHTADER
NSC FOR MCCORMICK AND TONG

E.O. 12958: N/A
TAGS: EFIN EINV ELAB PGOV CH
SUBJECT: SHANGHAI FUND MANAGERS ON JV'S AND COMPETITION

REF: SHANGHAI 654

SHANGHAI 00000657 001.2 OF 003


(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels or via
the internet.


1. (SBU) Summary: Joint venture securities firms in China only
succeed when the foreign partner has explicit management control
and can avoid cultural and managerial conflicts, according to
managers at two such joint ventures. Chinese security firms,
fearing their inability to compete, have asked the China
Securities Regulatory Commission (CSRC) to limit foreign
securities firms in China. The State Administration of Foreign
Exchange has delayed an increase in QFII quotas to reduce
foreign exchange inflows and will probably wait on increased
QDII outflows to balance larger QFII quotas. Recent gains in
the equity markets have been fueled by savings
disintermediation, but market fundamentals are sound and the
bull market could last as much as five years. The Ministry of
Labor and Social Security welcomes foreign involvement in
enterprise annuities, but poor tax incentives, strict controls
on how the funds are invested and high fixed costs mean that
these are unlikely to be profitable. End summary.


2. (SBU) Visiting Treasury DAS Mark Sobel and Embassy Finance
Minister Counselor David Loevinger met with Fortis-Haitong
Investment Management Company CEO and Board Director Tian Rencan
on September 17 and Guotai Jun'an Securities Company Deputy
General Manager Tuo Qibin on September 18 in Shanghai. (Note:
Reftel reports other meetings made by the delegation. End
note.)

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JV's Fail When Partners Don't Focus on Strengths
-------------- ---


3. (SBU) Fortis-Haitong's Tian attributed the success of his
company to the hands-off approach taken by the Chinese partner
in the day-to-day running of the fund. In the formation of
their joint venture (JV),Fortis made sure that it had the power
to appoint the CEO, CMO and CIO. Haitong has control over the
appointment of the Chairman and the CFO. Tian said this was
intended to assure them that Fortis would not misappropriate
funds. This structure allows each JV partner to focus on its
relative strengths, Fortis on asset management and Haitong on
local marketing and distribution.


4. (SBU) Tian contrasted Fortis-Haitong's "successful" approach
with other, less successful, JV fund management companies. He
said that "most failures occur when the different management and
investment styles and objectives of the Chinese
partner-nominated Chairman conflict with those of the
foreign-partner-nominated General Manager." These conflicts
stem from differing risk management strategies and business
management techniques between the two sides. Cultural
differences also play a role in failed JVs, especially when the
Chinese partners intervene in the decision-making process, said
Tian.


5. (SBU) In a separate meeting, Guotai Jun'an Securities Firm
Deputy General Manager Tuo Qibin largely agreed with
Fortis-Haitong's Tian. Tuo admitted that the JV fund management
company established by Allianz and Guotai Jun'an has been
experiencing problems and that its performance is below the
partners' expectation. He blamed "Allianz's stubborn German
working style," for the problems since they have not adapted to
working "in the Chinese environment."

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Local Opposition to Opening the Securities Industry
-------------- --------------


6. (SBU) Guotai Jun'an's Tuo said that Chinese securities firms'
opposition to foreign investment in the securities sector stems
from the belief that local securities companies have no
comparative advantage that would allow them to compete. Should
they be allowed to operate, foreign firms would quickly hire the
limited supply of qualified staff. This would be a significant
problem since the local securities firms' compensation packages,

SHANGHAI 00000657 002.2 OF 003


and thus their ability to retain staff, are constrained by the
fact that they are state-owned enterprises, he said. Tuo said
this view was made clear to the China Securities Regulation
Committee (CSRC) at a meeting held in the second half of 2006.
At this meeting, local securities companies expressed their
concerns about the threats that foreign firms represented and
asked the CSRC for protection.


7. (SBU) Fortis-Haitong's Tian separately expressed his
agreement that the major obstacle to increased foreign
investment in China's securities industry comes from the local
securities industry. Only after local companies become
stronger, better managed and more competitive with foreign
companies would the regulators fully open China's securities
market to foreign investments.

--------------
Enterprise Annuities Developments
--------------


8. (SBU) According to Fortis-Haitong's Tian, the Ministry of
Labor and Social Security (MOLSS) is open to foreign involvement
in enterprise annuities. However, both a lack of tax incentives
and the 25 percent ceiling on equity allocations make the
products unattractive to both businesses and employees. As a
result, of the nine companies with enterprise annuities
licenses, half have no business. While Fortis-Haitong has
signed deals with 25 companies, totaling over RMB 1 billion (USD
133 million) in assets under management, high fixed costs mean
that it has yet to be profitable. Concerns about insufficient
profitability among existing licensees has made MOLSS reluctant
to issue new licenses and has threatened to de-license firms
that are not using licenses they have been issued.


9. (SBU) Nevertheless, the Chinese Government is pushing the
expansion of enterprise annuities and Tian expects significant
growth in this area of the market. According to Tian, the
State-Owned Assets Supervision and Administration Commission
(SASAC) has issued a circular to large SOEs requiring them to
submit draft annuities schemes by June 2008. CSRC has also
created a list of companies approved to manage assets.

-------------- --------------
QFII Quota Increase Delayed -- Huge Demand for QDII
-------------- --------------


10. (SBU) Fortis-Haitong's Tian said that the CSRC had been
ready to increase the Qualified Foreign Institutional Investor
(QFII) quota from USD 10 billion to USD 30 billion. However,
over-liquidity in the capital markets led the regulators,
especially the State Administration of Foreign Exchange (SAFE),
to delay this increase until there were more capital outflows
through the Qualified Domestic Institutional Investor (QDII)
programs to set off the capital inflows from increasing the QFII
quotas. Tian also noted that due to volatility in the equity
market, several QFIIs had sold off part of their holdings in an
attempt to short the market. Additionally, the CSRC cited this
as a justification for delaying the QFII quota increase by
saying that there was no need to increase the QFII quota until
the original quota has been fully utilized.


11. (SBU) Tian said that the QFII requirement that investments
be held for minimum periods make them difficult to use in some
markets, such as Japan, which requires mutual funds to be
redeemable daily. Moreover, given SAFE's desire to promote
capital outflows, Tian saw little justification in requiring
QFIIs to hold their investments for minimum periods. Still,
Fortis-Haitong is interested in expanding the QFII program to
include alternative investment such as private equity.


12. (SBU) Tian said that there is a huge demand by Chinese
investors for QDII products. While investors had been focused
on the huge gains in China's equity markets, they were beginning
to seek ways to diversify their portfolios. Fortis-Haitong is
in the process of designing a QDII product that included Chinese
companies listed overseas. Tian attributed the success and
massive oversubscription of Southern Fund Management Company's
QDII product, issued in September, to the fact that there had

SHANGHAI 00000657 003.2 OF 003


been a dearth of new mutual funds issuances.


13. (U) Embassy Finatt has cleared on this cable.
JARRETT